Jayant M Thakur: Why audit committees won't work?

While the expectations remain high, these committees are mostly under-powered and under-qualified

There are too many expectations from the new concept of "audit committees" the world over and increasingly also in India. However, not at all in proportion of the expectations and responsibilities, are the powers and qualifications of their members and chairmen.

Even the system of appointment and remunerating them is self-defeating. Are we then heading for another major disappointment?

I don't think I would be exaggerating if I say that the audit committee is central to the new paradigm of good corporate governance. The reasons for giving it so much importance are apparent. It was felt that most of the corporate frauds and mismanagement were financial and accounting in nature.

The old system was of management running the show in every way "" they ran the company, they wrote the books, they appointed the statutory as well as the internal auditors, they decided their remuneration, they decided if they should be removed, what additional revenues they should provide to the statutory auditors and so on.

The statutory auditors and the internal auditors are supposed to be checking on the management but they are appointed and remunerated by the management.

What was needed was someone else who would act as an intermediary between the management and auditors on the one hand and the management and the shareholders on the other with regard to financial, accounting and audit matters.

Such persons should have no connection with the management which could affect their independence. They would oversee the financial accounting and reporting systems to ensure that there are good internal controls and that the financial information being collected is correctly and fairly presented in compliance with the letter and spirit of accounting standards.

This committee would appoint and remove statutory and internal auditors and decide on their remuneration. Any extra services by the statutory auditors "" the source of many an argument that this diluted their independence "" would be subject to approval by this committee. Powers commensurate to these functions will be given to them.

This, it was felt would finally solve the problem of corporate frauds and accounting manipulations. How realistic are these expectations?

To start with, who will appoint the members of the audit committee and its chairman? The appointment will be made by the promoters and management of the company. No special or exclusive right is given to the small and outside shareholders.

Thus, while they are supposed to ensure that the management and promoters do not commit financial fraud and present a true accounting picture, they are appointed by these very people only. They can also be removed by these very people. Their remuneration will also be decided by them.

It is not required that any of the members of the audit committee be qualified chartered accountants. Strangely, one of the reports on model codes expressly states that no qualification is necessary.

The Blue Ribbon committee of USA formed specifically for the role of audit committees goes even further and state no qualification or even "expertise" is needed "" what is needed is "intelligence, diligence, a probing mind and a certain basic 'financial literacy'."

However, is this even nearly adequate to grasp the complicated accounting standards and requirements? Fortunately, at least in India, the Naresh Chandra committee recognised this problem and accepted that "... there are skill gaps.

While one member of the committee may be positioned as the one having 'financial and accounting knowledge', it is worth asking how deep that knowledge is, especially given the new accounting standards and complexities." However, despite this realisation, the legal requirement remains one of mere financial literacy.

Who will decide on the remuneration of members of the audit committee? Again, it will be the management/promoters. There is no minimum remuneration assured. It is rather assumed and expected that they will do their job selflessly.

Here again, the Naresh Chandra committee recognised this problem and stated that "... nobody except one who is seeped in altruism will want to spend an extra five to seven days doing audit committee work, all for a sitting fee of Rs 5,000. So they don't."

They do have several powers. They can seek information on issues. They can obtain legal or other professional advice and so on. However, there are no independent measures given to enforce them. There is no assured separate funding. Even their reporting will be to the main board, though there are some token powers.

Their functions are vast. They are supposed to oversee the total financial reporting process. They are supposed to "ensure" that the information disclosed in the financial statements is "correct, sufficient and credible".

They will have to review the adequacy of internal control systems and internal audit systems and functions of the company. And so on and so forth.

So great are the functions of the audit committee that, as early as 1998, the Blue Ribbon report on audit committees repeatedly asked for a "safe harbour" for members of audit committees so that they will not be held liable on the ground that they did not perform or if the financial reporting was found to be containing inaccurate statements.

So, will this under-powered and under-qualified commitee meet the huge expectations of squeaky clean corporate accounting and financial management? Or will it need urgent revision as frustration grows?

Or, will this committee be the next group of people on whom the blame will conveniently be passed when frauds and mismanagement are again found.

Today, when such wrongs are discovered, we ask, "What were the auditors doing"? Tomorrow, the question will be, "What was the audit committee doing"? Will you, as a member of the audit committee or as its chairman, be ready and confident to answer this question?

The author is a chartered accountant